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Reminder: Private Mortgage Insurance is Temporary

Private Mortgage Insurance or PMI lets home buyers enter into a mortgage with as little as 3.5% down. The lender will require that this coverage continue until the borrowers equity is 20% of the home’s value. This NY Times article serves as a good reminder to borrowers on the fact that this rather expensive insurance is temporary.

Home buyers who can’t put at least 20 percent down usually have to carry private mortgage insurance, often an expensive proposition. One good thing about mortgage insurance, though, is that it doesn’t last forever.

Private mortgage insurance protects the lender in the event that a borrower stops making payments before building up much equity in the property. But a borrower who diligently pays down a loan, eventually crossing that 20 percent equity threshold, is no longer considered a big risk, and can expect to be rewarded with cancellation of the mortgage insurance requirement.

Under the Homeowners Protection Act of 1998, lenders must terminate mortgage insurance after a certain point, something that hadn’t been done consistently before then. The act set the termination date as the point at which the principal balance on the loan is scheduled to reach 78 percent of the original value of the home.

In other words, if you buy a home for $100,000 and put 10 percent down, your starting loan balance is $90,000. Once you have paid enough toward principal that the balance reaches $78,000, the mortgage insurance policy should be automatically canceled.

The bureau reminded servicers that automatic insurance cancellation is required even if the value of the home has declined from the original value (in other words, the sales price). Servicers may not require borrowers to obtain an appraisal before cancellation, as “the automatic termination date is not dependent on fluctuations in property value,” the bulletin said.

The law also creates a way to seek earlier cancellation. Borrowers may formally request this when the principal balance reaches 80 percent of the original value. In such a case, lenders aren’t under obligation to cancel, and have the right to require an appraisal. A borrower must be current on the loan to be considered.

Homeowners are likely to apply for early cancellation when they’ve been paying extra on the principal and when their equity has received a boost from appreciating home values, said Keith T. Gumbinger, the vice president of HSH.com, a financial publisher. But lenders’ policies usually dictate that “insurance can’t be canceled for a minimum of two years, regardless of what happens,” he said, “particularly when almost all the equity appreciation has been due to property price appreciation. Conditions could quickly go the other way.”

Still, the bureau’s bulletin emphasized to servicers that they must consider borrowers’ cancellation requests using the 80 percent threshold established under the Homeowners Protection Act, rather than a stricter threshold set by investors.

The cancellation rules do not apply to the low-down-payment loans backed by the Federal Housing Administration; borrowers must pay insurance for as long as they have an F.H.A. loan.

Borrowers are often confused about when mortgage insurance should be terminated, said Nicole Hamilton, the chief executive of Tactile Finance in New York, which markets software that allows lenders to help borrowers compare the costs and equity considerations of various loan types.

High-tech tools that clearly show a mortgage shopper what will happen to that loan over time — including the point at which insurance payments will no longer be necessary — can help demystify the process and improve the lender’s reputation for customer service, she said.

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